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Policy Brief No.

58

Building New Roads through Public-Private


Partnerships: Frequently Asked Questions
by Leonard C. Gilroy, Robert W. Poole, Jr., Peter Samuel, and Geoffrey Segal

What is a Public-Private Partnership? What are the benefits to state governments?

P ublic-Private Partnerships (PPPs or P3s) are collabo-


rations between governments and private companies
that aim to improve public services and infrastructure in a
PPPs are an effective way of financing, managing and
operating roads while minimizing taxpayer costs and risks.
Governments across the country and around the world are
manner which captures the benefits of private sector involve- seeking ways to finance much-needed infrastructure projects
ment (such as cost- and time-savings) while maintaining and trying to deliver better services to taxpayers. Public-pri-
public accountability. vate partnerships maximize the strengths of both the public
While PPPs can take a variety of forms, in transportation, and private sectors, offering taxpayers more efficiency,
long-term PPPs are increasingly being used for new road accountability, and cost- and time-savings. PPPs can be used
construction and modernizing existing roadways. These PPPs to build roads and highway projects that may have been
involve a private company investing risk capital to design, delayed or shelved altogether due to fiscal constraints.
finance, construct, operate, and maintain a roadway for a In fact, the major highway funding shortfall is a key
specific term during which it collects toll revenues from the reason governments are increasingly turning to long-term
users. The public agency oversees all aspects of the agree- PPPs to deliver new transportation projects. A recent Federal
ment, from maintenance to setting toll rates. In some cases Highway Administration report estimated that the annual
the private toll company pays the public agency an upfront capital investment in our highways totals $68 billion, which
fee for the contract, and in others the public and private is $6 billion less than what’s needed simply to properly
partners share in the revenue generated by the road. When maintain the condition of our highways and bridges. More-
the contract expires, the government can negotiate a new over, an additional $51 billion per year would be needed to
arrangement or take over the facility at no cost. improve and expand the highway network just to keep up

R e a s o n F o u n d a t i o n • w w w . r e a s o n . o r g
with the increasing demand for auto and truck travel.
The existing state and federal fuel tax and highway
trust fund system is unable to meet these investment needs.
Neither Congress nor most state legislatures have increased
fuel taxes to levels that would even offset increases in fuel
efficiency and inflation, let alone funding needed road
maintenance and increased travel demand. So increasingly,
states are turning to toll finance and PPPs to begin to fill the
funding gap.

How common are public-private partnerships in the


transportation world?
PPPs for complex, multi-billion dollar transportation
projects have been used for decades in Europe, and more
recently in Australia and Latin America. During the 1990s
they began to be used in the United States and Canada as
The state (or county or city) has flexibility in how it
well. PPP toll projects are in operation in California, Texas,
negotiates the lease payments. Texas and Virginia have both
and Virginia, as well as several Canadian provinces. Large
negotiated long-term leases which provide for a smaller
transportation PPPs in excess of $1 billion are in operation
upfront payment but a 50/50 profit share beyond a set rate
or under construction in Melbourne, Sydney, Paris, Israel,
of return. In Europe, concession agreements have been
Santiago, and Toronto.
crafted which provide annual payments with no upfront fee.
What is a long-term concession? In Australia, the bidding on one particular project was not
based on the size of the concession fee but on the lowest toll
Concessions are essentially leases, and the term long-
rates.
term concession is generally used to describe PPPs where
For a state entering into a concession deal, there are
the private toll road company designs, finances, constructs
two key trade-offs between upfront payment versus ongo-
and operates a toll facility for anywhere from 30 to 99 years.
ing lease revenues over the life of the agreement: (1) cur-
rent capital needs versus long-term needs, and (2) a “sure
How does a long-term concession PPP work? thing” (upfront payment) versus some risk as to what future
In exchange for a long-term lease arrangement, an revenues may be. There is no right answer; each state must
investor-owned company will finance, design, build, oper- weigh the trade-offs involved with each individual project.
ate, modernize, and maintain a highway project, financ- Regardless of how the state is paid for the concession,
ing its expenditures from the toll revenues it is allowed to when it involves the construction of a new roadway, the tax-
charge. However, the state or local government still owns payers gain a state-owned asset that can continue to provide
the roadway and protects the public interest through nego- mobility and generate revenue long after the lease term.
tiating and enforcing the terms of the concession contract.
Essentially this model extends the investor-owned “Now, much of [our] vital infrastructure is showing its age […] And
at the very same time, our growing economy is placing increasing
utility concept from network industries like electricity and
demands on every one of our systems, even while the funding
telecommunications to highways. Just as those industries
sources we have relied on are less and less able to keep pace.
are vital to the public interest, so too are highways. If we are going to escape the forces of the perfect storm that
are gathering before us, we must find fresh angles and creative
Are there other ways of involving private enterprise ways to improve the performance of our transportation systems.”
in toll roads without large upfront payments to gov- —U.S. Secretary of Transportation Mary Peters, Swearing-in Cer-
ernments and nothing for taxpayers beyond that? emony, Oct. 17, 2006

Building New Roads through Public-Private Partnerships


2 Reason Foundation • www.reason.org
Interstates will be far more costly than most people real-
ize. The long-term concession model can raise significant
investment capital for new transportation infrastructure
because it is attractive to many different types of inves-
tors, including equity investors and lenders. For example,
highway infrastructure is increasingly appealing to institu-
tional investors like pension funds that seek stable, low-risk
investment opportunities.
There is also growing evidence that the long-term
concession model can generate significantly more fund-
ing for a given toll project than the traditional government
financing models. For a new toll road in Texas, for example,
a toll traffic and revenue study estimated the state’s ability
to finance $600 million, less than half of the project’s total
$1.3 billion cost. Texas DOT turned to a long-term conces-
sion approach, in which the private sector will finance the
What are the advantages of PPP toll roads? entire $1.3 billion project, in exchange for a 50-year conces-
sion. Four factors seem to drive these differences:
1. Delivery of needed transportation infrastructure:
PPPs offer governments and taxpayers a way to fund roads 1. The concession agreement adds certainty to future toll
that otherwise would not be built. Many states are facing rates that are less predictable under public toll agencies.
a “perfect storm” in transportation: growing transporta- 2. The private sector is more aggressive in both attracting
tion needs are outstripping available funding; the need for motorists and in reducing costs (e.g., by making full use
maintenance and renovation of existing systems is using up of electronic toll collection).
available resources; and congestion is getting worse by the
3. The private sector can take depreciation as a tax write-
day. In short, there’s just not enough funding to adequately
off, like any other business, but toll agencies can’t, since
maintain the roads we already have, much less build all of
they pay no income taxes.
the new roads needed to relieve traffic congestion.
With long-term PPPs, not only does the private sector 4. Infrastructure has become a fashionable asset class for
take on much or all of the responsibility of financing new a host of investors that do not normally invest in tax-
roads, but governments can use the funds generated exempt toll-agency bonds. Michael Wilkins of Standard
through upfront concession fees or revenue sharing agree- & Poor’s recently estimated that $100-150 billion in
ments to invest in the rest of their transportation infrastruc- private capital was raised in 2006 alone to invest in
ture. For example, Indiana will be using the $3.8 billion infrastructure.
payment it received for the Indiana Toll Road concession to 3. Shifting risk from taxpayers to investors: PPPs
cover a multi-billion dollar funding shortfall in the state’s involve parceling out duties and risks to the party best able
10-year transportation plan; planned transportation invest- to handle them. The state is the party best able to handle
ments statewide that were previously unfunded are now rights-of-way and environmental permitting, so those roles
able to be undertaken. remain with the state. The private sector in these deals
Further, taxpayers and drivers enjoy a double benefit nearly always takes the risks of construction cost overruns
through PPPs: not only do they benefit from new roads that and possible traffic and revenue shortfalls. Given the dif-
reduce congestion, but the willingness of the private sector ficulty of completing transportation mega-projects on time
to finance highway projects offers policymakers an attractive and within budget, being able to shift construction and traf-
alternative to tax hikes as a means of funding new roads. fic/revenue risk to investors is a major advantage.
2. Ability to raise large, new sources of capital for toll 4. More businesslike approach: Compared with gov-
projects: Rebuilding and modernizing our freeways and ernment-run toll agencies, private toll road companies are
less susceptible to pressure from narrow political interests

Reason Foundation • www.reason.org 3 Building New Roads through Public-Private Partnerships


and are more customer service oriented, since it directly
affects their economic viability. They are quick to adopt
cost-saving and customer-service oriented technology and
specialized products and services to meet customer needs.
5. Major innovations: One of the most important
advantages of investor-owned toll road companies is their
motivation to innovate in order to solve difficult problems
or improve their service to customers. Today, we know that
variable pricing (also known as value pricing) works very
well to eliminate traffic congestion during peak periods,
actually maximizing throughput while maintaining high
speeds. It was a private toll company in California that took
the initiative to introduce and perfect value pricing; no state
toll agency was willing to take the risk of doing so.
Toll road companies are also good at value engineer- that the private company has to clear dead animals from the
ing—thinking outside the box to dramatically reduce the road within eight hours and fill potholes within 24 hours.
costs of new capacity. A case in point is the forthcoming The public interest is protected by incorporating enforce-
High-Occupancy Toll (HOT) lanes project on the Capital able, detailed provisions and requirements into the contract
Beltway in northern Virginia. The Virginia DOT’s plans to to cover such things as:
add two HOV lanes in each direction on that section of the
• Who pays for future expansions and rebuildings;
Beltway would have cost taxpayers $3 billion—money that
Virginia did not have. The private sector team’s unsolicited • How decisions on the scope and timing of those projects
proposal called for adding two HOT lanes in each direc- will be reached;
tion—the same amount of physical capacity—for under • What performance will be required of the toll road and
$1 billion. The savings came from value engineering that the private toll company (i.e., safety, maintenance,
reduced or eliminated many expensive bells and whistles plowing, and many other requirements);
held little real benefit.
• How the contract can be amended without unfairness to
Private toll road companies are motivated to think out-
either party;
side the box, to solve difficult design problems. In France,
an unsolicited proposal from a private toll firm resolved a • How to deal with failures to comply with the agreement;
30-year impasse over how to complete the missing link of • Provisions for early termination of the agreement;
the A86 Paris ring road, which would need to pass through • What protections (if any) will be provided to the com-
historic Versailles. The company is building a deep-bore pany from state-funded competing routes; and
tunnel underneath—instead of through—Versailles, and is
• What limits on toll rates or rate of return there will be.
financing the $2 billion project with value-priced tolls.

How is the public interest protected in a PPP? Won’t Isn’t 50+ years far too long to lease valuable roads?
the state be losing control of the public highways? State governments are committing future generations
when they cannot predict what the needs will be.
Roads built using public-private partnerships belong
to the state. When drafting the contract with the private It is entirely possible that changing circumstances will
sector, the government can—and should—­completely pro- require revisions to the lease. That is why all concession
tect taxpayers by demanding accountability. agreements have detailed provisions to permit changes
Concession agreements are typically several hundred during their term. Concession agreements have detailed
pages long and may incorporate other documents (e.g., provisions for negotiating and arbitrating disputes, and
detailed performance standards) by reference. No detail is employing independent parties to make fair financial esti-
too small; for instance, the Indiana Toll Road lease specifies mates. The only limit to changes in the terms of the conces-

Building New Roads through Public-Private Partnerships


4 Reason Foundation • www.reason.org
There are also several billion-dollar-plus proposals
being negotiated in Virginia: new HOT lanes on the Capitol
Beltway (I-495) and I-95/I-395 in northern Virginia, and
a new Crossing complex in Hampton Roads. Colorado is
also receiving private sector proposals, as are Florida and
Georgia. In all, 21 states and one U.S. territory have passed
legislation enabling the use of PPPs for highway projects.
Overseas, investor-built toll roads are far more
common; in fact, they have become the conventional way to
provide major new highway capacity in many countries. The
private sector is financing, building, and operating most of
the major new highways in countries as diverse as China,
India, Canada, Britain, Ireland, France, Spain, Italy, Greece,
Hungary, Poland, Pakistan, Turkey, Indonesia, Malaysia,
sion is normally that neither side should be disadvantaged
Israel, South Africa, Australia, Philippines, Argentina,
financially by the changes.
Brazil, Chile, and Jamaica. Most of the postwar toll motor-
State governments regularly make commitments
way systems in France, Italy, Portugal, and Spain were also
that impact taxpayers for longer than 50 years. Bonding
built using the concession model.
for infrastructure and changing pension benefits are two
Though PPPs in transportation are relatively new to the
examples. Because the capital costs for major infrastruc-
U.S., over the past 15 years, the private sector has built sev-
ture projects are so high, it is necessary to finance them
eral new toll roads under long-term franchise agreements
over long periods of time.
with state governments, including the 91 Express Lanes in
Orange County, California, the SR 125 in San Diego, the
What happens if the private concessionaires go
Dulles Greenway in Northern Virginia, and the Camino-
bankrupt after a new toll road is built?
Colombia Toll Road near Laredo, Texas.
If a concessionaire were to file for bankruptcy or close
during a lease period, the contract would end and the state “Texas is showing the rest of the country how to expand major
would take the toll road back without any obligation to parts of its highway system by leveraging private capital. That is
why more states need to follow Texas’ lead and pass legislation
repay concession fees. The state would essentially get the
allowing the private sector a broader role in funding and operating
road for “free,” and it could then re-concession the toll road
transportation systems.” – former U.S. Secretary of Transportation,
or run it itself. Norman Mineta

Where are PPPs being used to build new toll road


projects? Why are so many of the companies building toll
roads foreign companies?
There are more than $25 billion in PPP highway proj-
Until recently the United States had used only public-
ects planned or already approved across the United States.
sector agencies to build and operate toll roads, so there has
The largest is the Trans Texas Corridor-35 (TTC-35) where
been no opportunity for the industry to grow in the U.S.
a private consortium has been chosen by the Texas DOT to
Foreign countries have been using transportation PPPs for
build 316 miles of new toll road. The company will spend
decades, so it makes sense that foreign firms would be the
about $7.2 billion—$6 billion on construction plus $1.2
most experienced toll road providers. A responsible state
billon in concession fees—in return for a 50-year conces-
government will take experience and track record into
sion agreement. This project will produce a completely
account when choosing a private firm to operate a roadway.
new route between Dallas and San Antonio, providing an
As the U.S. market matures, we are starting to see the
alternative to congested I-35. The new road will eventually
emergence of domestic toll road companies. Already, joint
be extended south to Mexico and north to the Oklahoma
ventures between U.S. and global companies are bidding on
state line.

Reason Foundation • www.reason.org 5 Building New Roads through Public-Private Partnerships


strong interest in keeping their customers healthy and happy
and maintaining their business. Further, foreign firms are
subject to the same legal and regulatory security require-
ments as any domestic firm or public agency. Concession
agreements usually provide for state police to do their polic-
ing on the road, as before. Security vetting of employees can
be implemented, and improved surveillance systems made
part of the concession agreement.

Won’t private companies just try to make a profit by


raising tolls or reducing service?
Lowering service would lose the toll company paying
PPP projects—Fluor/Transurban, Zachry/Cintra, Kiewit/
customers, which is the last thing a business wants to do.
Macquarie, to name several recent examples. Likewise, U.S.
Higher tolls can also drive customers away if they aren’t
financial institutions have been creating multi-billion-dollar
accompanied by reduced travel times and better service.
infrastructure investment funds, so these deals will soon be
While it is true that many drivers aren’t able to be flexible
tapping U.S. capital in a major way.
about the route they take to work, there are always enough
It’s important to remember that even deals which
drivers with options to keep the toll company focused on
only involve foreign companies are very good for the U.S.
service. Toll road companies have a strong incentive to
economy. Attracting billions of dollars in global capital (and
increase profits by greater efficiency—by doing more with
expertise) to modernize America’s vital highway infrastruc-
less. A more efficient toll road will benefit users.
ture and provide local employment in both operation and
construction is a large net gain for this country. Further
But couldn’t a private company double tolls and
investment in our transportation infrastructure only makes
make just as much money with half the traffic?
the U.S. more competitive in the global marketplace as well.
The fear that PPPs will lead to uncontrolled, sky-high
Isn’t it wrong to sell off a major government transpor- tolls is unjustified. Most concession agreements to date
tation asset to private or overseas interests? specify an annual cap on toll increases using various infla-
tion indices. It is important to note that those caps are
Concessions are not the sale of an asset. Concessions
ceilings; the actual rates a company charges will depend on
are essentially a lease—only the right to do business under
market conditions. Before entering into any toll road proj-
highly specified contractual conditions is being transferred
ect, a company would develop detailed traffic and revenue
to a private entity. The state retains full title and ownership
forecasts to determine how many vehicles would use the toll
of the asset itself.
road at what price; too high a toll rate means fewer choose
to use the toll road, which generally means lower total rev-
In the post 9/11 world, wouldn’t we be safer if the
enue. So the toll road must select the rate that maximizes
government or U.S. companies —as opposed to for-
total revenue. Over time, a company may choose to set the
eign companies—were managing U.S. infrastructure?
toll rate lower than the caps provided in the concession
Fears regarding the foreign management of domestic agreement, especially in recession years, to attract more
infrastructure are based on the prevalent, but false, myth drivers.
that there is a greater risk of a security breach when Ameri- By contrast, there are some types of PPP projects—such
can infrastructure assets are managed by foreigners. For- as HOT lanes or Express Toll Lanes—where tolling is
eign-owned companies have successfully operated numerous used to manage traffic flow. Toll rates are allowed to vary
critical infrastructure systems and assets in the United throughout the day to keep these lanes flowing freely.
States—from airports to highways to water and wastewa- In those cases, pre-defined limits on toll rates defeat the
ter plants—for many years. The country has remained safe purpose. When such lanes are operated under a concession
under these arrangements because these companies have a

Building New Roads through Public-Private Partnerships


6 Reason Foundation • www.reason.org
agreement, instead of limiting the toll rates, the agree-
ment can limit the rate of return the company is allowed to
make, with surplus revenues going into a state highway or
transportation fund. This is how California’s original pilot
program for long-term concessions dealt with the issue, as
have similar deals in Texas and Virginia.

“[O]ur economy depends on us having the most efficient, reliable


transportation system in the world. If we want people working in
America, we’ve got to make sure our highways and roads are modern.
We’ve got to bring up this transportation system into the 21st century.”
—U.S. President George W. Bush, Safe, Accountable, Flexible,
Efficient Transportation Equity Act Signing Ceremony, Aug. 10,
2005 transportation plan. And for new roadways the state builds
that are not in its existing plan and which do fall within a
Isn’t this just a ploy by the major investment banks narrowly-defined competition zone, the current approach is
on Wall Street to earn big commissions? to spell out a compensation formula. The idea is to achieve
a balance between, on one hand, limiting the risk to toll
Toll roads have to be financed, whether government
road finance providers (of potentially unlimited competi-
toll authorities sponsor them or toll road companies do.
tion from taxpayer-provided “free” roads) and, on the other
Both public and private financings involve big commis-
hand, the public interest.
sions to the financiers who put together these transactions.
Two recent long-term lease transactions provide a
Private transactions sometimes require smaller financing
useful illustration. For the Chicago Skyway concession,
commissions than do the public equivalent because part of
there were no protections for the private-sector lessee. For
the money is private equity, and there is less need for large
the Indiana Toll Road, the concession agreement set up a
reserve funds. These services are paid for by the toll compa-
narrow competition zone alongside the toll road. The state
nies, who have every incentive to shop around for the best
may add short, limited-access parallel roads (e.g., local
service and the lowest commission.
freeways), but if it builds a long-distance road within the
competition zone, there’s a formula for compensating the
Non-compete clauses in concession agreements
prevent the construction or improvement of parallel private sector for lost toll revenue.
roads, preventing competition. Isn’t this bad?
Couldn’t the public sector raise just as much money
Nearly all self-financing toll roads, whether government as the private concession leases?
or privately owned, need some protection from tax-financed
Not likely. The single most important factor driving the
alternative roads. This is akin to the world trade rules that
higher valuation accorded to concession toll road deals is
limit European governments subsidizing Airbus. Just as
the certainty of being able to set toll rates over the life of the
Boeing cannot be expected to sell in competition with a
agreement to ensure a return on investment. No one has yet
heavily subsidized Airbus, so toll roads cannot be financed if
devised a way to bind future elected officials from interfer-
taxes are used in unrestricted fashion to provide equivalent
ing in the toll-setting decisions of state toll agencies—and
parallel service free of charge.
the capital markets take that into account in judging what
Clauses designed to protect toll road operators from
they will finance. But by allowing the state to enter into
the construction of new, parallel “free” roads have evolved
concession agreements—which are legally enforceable long-
over the years. The earliest approach—an outright ban on
term contracts—a legislature can choose to limit its future
alternative facilities—proved to be unnecessary as well as
ability to intervene in toll-setting decisions, thus creating
politically unpopular, giving rise to modern agreements
certainty and stability, which are essential to encouraging
that include a much wider definition of what the state
investment.
may build: generally, everything in its current long-range

Reason Foundation • www.reason.org 7 Building New Roads through Public-Private Partnerships


About the Authors
Leonard C. Gilroy, AICP is a senior policy analyst at
Reason Foundation, a nonprofit think tank advancing free
R EASON FOUNDATION’s
mission is to advance a free
society by developing, apply-
minds and free markets. He is the managing editor of the ing, and promoting libertarian
world’s most respected newsletter on privatization, Priva- principles, including individual
tization Watch, and is the editor of the widely-read Annual liberty, free markets, and the
Privatization Report, which examines trends and chroni- rule of law. We use journalism
cles the experiences of local, state, and federal governments and public policy research to
in bringing competition to public services. influence the frameworks and
Robert W. Poole, Jr. is Director of Transportation actions of policymakers, journal-
Studies and founder of Reason Foundation in Los Angeles. ists, and opinion leaders.
He has advised the U.S., California, and Florida depart- For more information on Reason Foundation and
ments of transportation, and served 18 months as a member our transportation research, please contact the appro-
of California’s Commission on Transportation Investment. priate Reason staff member:
He has also advised the last four White Houses on various
transportation policy issues. Transportation Planners and Officials
In the field of surface transportation, Poole has advised
the Federal Highway Administration, the Federal Transit Amy Pelletier
Administration, the White House Office of Policy Develop- Outreach Director
ment, National Economic Council, Government Account- (949) 444-8703
ability Office, and state DOTs in numerous states. Amy.Pelletier@Reason.org
Peter Samuel founded and edited Toll Roads News- Robert Poole
letter, now replaced by the comprehensive Web site, www. Director of Transportation Studies
tollroadsnews.com. He has been a contributing editor to (310) 292-2386
World Highways and Intelligent Transportation Systems Robert.Poole@Reason.org
International.
Geoffrey F. Segal is the director of privatization Government Officials
and government reform at Reason Foundation. Mr. Segal
Mike Flynn
recently served as an advisor to Florida Gov. Jeb Bush’s
Director of Government Affairs
Center for Efficient Government. n
(703) 626-5932
Mike.Flynn@Reason.org

Media

Chris Mitchell
Director of Communications
(310) 367-6109
Chris.Mitchell@Reason.org

Reason’s transportation research and commentary


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Building New Roads through Public-Private Partnerships


8 Reason Foundation • www.reason.org